Responding to requests that the Forum resume attention to issues raised by
corporate stock buybacks,[1] I will welcome
suggestions for our selection of a company-specific case to present an
example of both corporate and investor decisions about the use of capital
to produce goods and services.[2]

Candidates will be considered based on the issues that are relevant, as
well as on how effectively those issues can be addressed.[3]
Some of the issues that have been identified as important to Forum
participants are summarized below, and I will of course appreciate your
advice to refine our understanding of what may be relevant.

As a
foundation for any review of proposed stock buybacks, it must be
understood that for most U.S. companies the use of corporate capital for
this or any other purpose is strictly a decision for the board of
directors.

Ø

Should capital be returned to investors as an alternative to
improving management of the business?
If the board has determined that the company’s executive
managers cannot be relied upon to use the capital for the
competitive production of goods and services, the logical next
step in most cases would be to replace those managers with new
ones who can be relied upon to implement production
efficiencies, improve product quality, expand markets, develop
new products, or make some other use of capital to develop the
business. Alternatively, if the board determines that replacing
managers is not a practical strategy, directors would presumably
want to sell the business – whether the whole corporation or its
undermanaged unit – to someone who can pay a price based on the
ability to improve management, and thus return all of the
business unit’s capital to investors rather than just some of
it. There can of course be some kind of sound reason for
returning some of a company’s capital to investors, but whatever
it is needs to be considered by the board in this practical
context of why the company is continuing to employ managers if
they are unable to make use of the capital to develop a
competitive business.

Ø

Will the corporation benefit from requiring shareholder approval of a buyback plan?
Noting that shareholder approval requirements are common in
jurisdictions outside the U.S.,[4]
establishing a provision for shareholder voting approval of
stock buybacks might be considered by a company’s board as
either a case-specific condition or as a permanent governance
policy to insulate the company from pressures to accommodate
investor constituencies interested in short term pricing of the
company’s shares.

Ø

Should a company’s officers be made responsible for trading in
the company’s stock?
There has been a great deal of research, analysis and debate
about whether a company’s managers can be expected to conduct
buybacks efficiently at prices below intrinsic value, and it
should also be noted that “perfect market” theory suggests that
efforts to buy the stock at bargain prices will always be
futile. Concerns are also raised about whether a company’s
managers may be biased by subjective evaluations, compromised by
insider information, or influenced by self-interest.

Ø

Are stock buybacks a legitimate use of corporate capital?
Both economic principles and legal theory[5]
view corporate capital as having been contributed for use in a
business enterprise. Buybacks that are justified as investments
in “undervalued” company stock, or as support for market pricing
to benefit some of the current holders of previously issued
stock, may not be consistent with those understandings of
purpose.

The
issues for investors to consider are much simpler. Assuming a proposed
buyback is rationally conceived, the analysis is essentially based on
whether the shareholder is concerned with short term pricing – either for
selling the stock or for determining the current NAV of a professionally
managed fund – or with the long term realizable value of a continuing
investment.

Ø

Does an investor concerned with short term pricing need to
consider the long term effects of a proposed buyback?
Long term effects of a buyback on a company’s access to capital
can influence current valuations of a company, and in that
context an investor interested in short term pricing must
consider the relative influences on trading markets of the
apparent long term intrinsic value implications and immediate
“financial engineering” benefits.

Ø

How will a long term holder of the company’s stock benefit from
a buyback?
The continuing holder of stock does not receive any of the
theoretical benefit of money being “returned” to investors,
since that is given only to investors who sell into the buyback.
The intrinsic value of the company is likely to be reduced by
its diminished access to capital and resulting limited
adaptability, but the buyback’s reduction in shares outstanding
will increase the continuing holder’s proportional interest in
that diminished intrinsic value. The long term investor
therefore must analyze the relative effects of both the
increased business risk and increased allocation of equity to
determine the net benefit, or to determine whether to sell or
continue holding.

Ø

Can an indexed investor benefit from buybacks?
Recent discussions of this question have not developed any
theories of benefit. Since indexed investors cannot decide to
sell any of their shares into a buyback, they will not be
receiving any of the funds being “returned” to investors. It
must also be assumed that substantially all of the “returned”
money received by other investors will be committed to secondary
market purchases of previously issued equity securities, rather
than contributed to increased capital of the companies in the
index to improve their production of goods and services.
Finally, that use of “returned” investment to purchase
previously issued equity securities will add to buy-side demand
that increases the prices the indexed investor must pay for the
equity it is currently buying for realization of long term
values that will not be enhanced by the buybacks.

Ø

Should a shareholder present or vote in support of a proxy
proposal to require shareholder approval of corporate stock
buybacks?
As indicated in the section on corporate questions
above, the requirement of shareholder approval is common
outside the U.S. and may support responsible management as well
as the interests of long term investors.

ttt

It
should be emphasized that this summary of preliminary questions is
intended to stimulate broader thinking, and to encourage your
participation in guiding our progress.

[2]For previously referenced news reports and research
of relevant issues, see the “Stock
Buyback Policy” section of the 2014 program’s website.

[3]It should be noted that some preference will be
given to candidates proposed by the subject company’s managers,
partly to demonstrate the Forum’s commitment to supporting
responsible corporate leadership, but also based on the assumption
that both the definition of issues and the responses to investor
interests may be more effective in a program initiated by the
people who have access to all the information relevant to their
company’s capital allocation decisions. See the August 11, 2014
Forum Report: Corporate Responsibilities for Issue Definition and
Information Access.

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